Iceland Melted… Greece Slipped…China Cracked

The interesting thing about international finance is that even a lot of professional economists don’t understand it very well. But lots of stuff was in the news last week … so here is a water cooler conversation starter to start your Monday.

China Shocks Currency Markets: 08.11.2015

China devalued its currency last night by the most in two decades. The move affects every asset class, commoditities to emerging-market currencies. The move will make China’s exports less expensive to world markets … which will theoretically improve China’s domestic economy. Imports purchased by Chinese consumers will become more expensive. There now exists the possibility of a global currency valuation war as markets and governments adjust.

In theory, without adjustments, Apple’s Chinese suppliers benefit from the move as they pay employees and vendors with Yuan and sell for Dollars. The U.S. in theory benefits from the stronger buying power of the dollar, but exports will suffer. Keep an eye on the Chinese real estate market as a considerable portion of this overheated sector is financed by off-shore lenders. The devaluation may add $10 billion to their repayment debt. The question will be whether or not they will be able to service that debt.

On a brighter side … Christmas is only 135 days away.

Look for an interesting week as global business and governments try to figure out adjustments.

UPDATE CHINA AND GREECE 8.10.2015

China stocks rallied on the Shanghai Composite Index closing 4.9% higher as the U.S. trading day starts. China’s government approved plans to overhauld state-owned enterprises to boost the economy.

The government intervention plan to stabalize the markets seems to be working … for the moment.

Greece is seeking to conclude talks on a new rescue program by tomorrow. That plan would make $93 billion available to Greece. That plan seems to be working … for the moment.

UPDATE CHINA

The Shanghai Composite Index rose 3.5 percent to 3,957.35 at the close, erasing a weekly drop. The Shenzhen Composite Index climbed 5 percent, the most since 2012, as technology shares rallied. China Securities Finance Corp., a state-backed agency that provides margin finance and liquidity to the market, has 2.5 trillion yuan to 3 trillion yuan ($483 billion) on tap to support stocks, people familiar with the matter said.

BloobergBusiness 7/17/15 @ 05:42 AM

Economists, at some point are likely to compare China’s approach to overall and market economic stability to the efforts of the U.S, (Think Economic Stimulus package and Quantitative Easing).

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Iceland Melted

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The economic meltdown that engulfed the world in 2008 began in sub-polar Iceland. 320,000 people inhabit Iceland, think Buffalo, NY.

Iceland’s government was infatuated by the prospects of creating the ‘Nordic Tiger’ by moving away from the traditional fishing economy into projects that were thermal energy driven such as hydro-electric dams and aluminium smelting plants. Some of the citizens warned that the government was creating modernization too rapidly while most were infatuated with loose credit and the possibility of wealth.

By 2008 the country’s three main banks had assumed $85 billion in debt — a debt load that was 10 times bigger the country’s economy. The average Icelander was $403,00 in debt and 25% of homeowners faced mortgage default. 85% of the banks failed.

Iceland was forced to adopt both austerity and capital controls. One Icelandic policy official said that “Capital Controls are our version of quantitative easing.” [Capital Controls prevent investors from freely exchanging the Icelandic Krona for foreign currency. This has helped prevent widespread capital flight and enabled Iceland to protect its financial system since the crisis hit.]

Something Worked

It has been a tough few years for Icelanders … but Iceland today is a showcase once more. The economy has staged a sound recovery. GDP is 2.7% while unemployment is 3.1%. Compare that to the EU and US. A resilient population coped with and mastered a painful restructuring.

On June 8, 2015, Iceland announced a plan to remove capital controls. Although investors, mostly hedge funds, will recover somewhere in the range of 12 to 31%, Jon Danielsson, a professor at the London School of Economics said, “It is a well-thought-out plan to get rid of the capital controls as quickly as possible. It put the interests of the economy first while being fair to foreign creditors.”

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Greece Slipped

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I am not sure whether Greece slipped or jumped off the financial cliff. The story continues to be writ. But here are some of their ever present problems:

Small undeveloped economy.

Long history of default and financial mismanagement.

An aversion to collecting or paying taxes.

Broad corruption.

An unsustainable pension system.

Productivity!

If Greece left the Euro, it would bring back the Drachma. [Iceland benefited by having its own currency which it could devalue and become more competitive in international trade and tourism … both important to reviving the economy.] They Greeks just have to be careful not to cause hyper-inflation.

Or the EU could impose Capital Controls like Iceland used. They worked for Iceland, but Greek and Icelandic cultures are different.

Or The Greeks and EU might create a parallel currency.

Greece has a notoriously inefficient public sector employment problem. Also Greek labor and product markets are very rigid by international comparison.

Tax collection has to go up. Evasion by the public costs the public coffers, which pays the government workers and pensioners, about $30 billion per year.

The Greeks got a bailout agreement as of 7/13/2015 which is far harsher than the one Greek voters rejected only a week earlier.Prime Minister Tsipras has to get his parliament to agree within the next 3 days.

The Greeks invented drama

Just look at it this way — the Greeks invented drama! Aeschylus developed the Greek Tragedy around 5th century BC. In describing the Greek Tragedy form of Drama, he might have said, ‘Why did my characters suffer greatly? It was their fate. Yet they struggled, in the hope that they could somehow avoid that fate.’ Nobody in the audience knows how this drama will end, but it appears certain that the characters in this play will suffer, perhaps greatly.’

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China Cracked

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Although the Chinese stock market rallied on Thursday and Friday, up 4.5 % or so based on heavy government buying, over $3.1 Trillion in market value has been erased since mid-June. [Note that the entire annual GDP of France is $2.8 Trillion.]

The Chinese government is acting quickly:

Stocks are not broadly owned in the market and the downturn is only a few weeks old.

If the market rebounds, in-country economic damage will be minimal. If it continues, look for possible global contagion based on the loss of a vibrant Chinese economy.

The government froze trading on 50% of the listed stocks. [A form of capital controls.]

The China Securities Futures Corporation now has unlimited credit support from the central bank. [Back in 1998 the Hong Kong government deployed a similar strategy during the global market meltdown.]

The CSFC has provided large sums of money to help sustain margin loans for stock buyers and has begun buying stock itself.

Stocks are apparently actively traded by only 9% of Chinese households.

The financial plates … cracked or broken?

The problem is that nobody really understands the risks involved when steep securities losses are suddenly incurred in a country where the markets are relatively new and the brokerage and asset management firms are weakly capitalized. We’ll soon know if only a few plates were cracked or the whole service is broken.